Now is not the time for central bank digital currencies
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Stephen Cecchetti is the Rosen Family Chair in International Finance at Brandeis International Business School. Kim Schoenholtz is Henry Kaufman Professor of the History of Financial Institutions and Markets at the NYU Stern School of Business. In this guest post, they argue that central bank digital currencies are a solution looking for a problem.
In a recent column, the FT’s Martin Wolf called on central banks to introduce their own retail digital currencies now. While we share many of Martin’s concerns about the importance of faster and cheaper payments, financial inclusion, and limiting private digital currencies, we cannot disagree more with his argument for digital currencies from the central bank (CBDC). In fact, we hope that central banks not Introduce universally available digital currencies, provided without limit in exchange for bank deposits and bearing interest – what we call a “universal” CBDC.
Our arguments are twofold. First, we don’t need CBDCs to promote faster payments, expand financial access, or limit private digital currencies. Second, the universal CBDC raises critical issues that threaten financial stability and privacy, and unnecessarily reinforce the role of the state in granting credit.
Let’s start with the payments. Today, the public and private sectors are already striving to provide cheaper, faster, more reliable and more accessible systems that work both within and across borders. For example, the euro zone has the TIPS system, with a processing time of 10 seconds at a cost of € 0.20 per transaction. Meanwhile, the UK has Faster Payments, Canada is testing Real-Time Rail, and the Federal Reserve is set to launch its own instant payments service, FedNow, in 2023. None of these require CBDC.
While the CBDC could add to the financial access, it is really government grants. Take India as an example. In 2014, the government offered no-frills accounts to everyone. To date, more than 420 million people have been brought into the financial system, with account balances averaging nearly US $ 50. No CBDC in sight.
As for private digital currencies, it’s a matter of regulation and taxation. And, given the obvious incentive from governments to protect seigniorage – to support state spending – they have reason to act whenever these private instruments become salient.
Then there is the issue of financial stability and credit creation. By their nature, CBDCs risk disintermediation and currency substitution. Suppose there is a bank run. It’s not hard to imagine that uninsured deposits would leak from private banks to the central bank, exacerbating strain on the financial system. And, for highly reliable central banks that operate in stable political and financial jurisdictions without capital controls, these flows could also come from abroad, undermining monetary stability in developing economies. Massive inflows would prompt major central banks to channel credit either directly or – using an extensive system of collateral and haircuts to redistribute funds – indirectly.
Finally, there is the issue of privacy. Since using CBDC means everything we do becomes traceable, it poses a serious threat to personal freedom. In theory, outsourcing compliance to “narrow banks” holding CBDCs could ensure confidentiality, but that would not stop authoritarian states. Moreover, this “delegation of compliance” would still lead to the problems described above of disintermediation, currency substitution and an increased role of the state in the allocation of credits.
To put it simply, central banks are supposed to take care of reduce systemic, while promoting financial efficiency and inclusion. Rather than rushing to offer CBDC for fear of being left behind, they should take it slow to ensure a safe design. In our view, this means stopping well before issuing universal, unlimited, interest-bearing CBDCs.